What did the Bank of England decide?
The Bank of England held interest rates steady as policymakers weighed a renewed inflation threat from the conflict involving Iran and the Middle East. Governor Andrew Bailey said higher energy prices would push up inflation in the coming months, but there was little evidence that price pressures were becoming embedded in the UK economy.
Bailey said there was underlying disinflation — slowing price growth — in the UK, while deputy governor Clare Lombardelli said it was not a close call to keep rates unchanged. The decision came as investors judged the Bank to be signalling caution, even as it warned that the outlook for energy prices remained a key uncertainty for inflation.
What did Andrew Bailey say about inflation?
Andrew Bailey said higher energy prices would raise inflation in the coming months as he began his press conference. However, he said there was little evidence that inflationary pressures were becoming embedded in the UK economy.
He said that there was “underlying disinflation” in the UK and later added that there was more evidence that the disinflation process was in place. He also said the world was so uncertain at the moment that it was harder to say how likely any single scenario was.
Bailey said the world felt as uncertain and volatile today as it did three months ago in April. He said it was hazardous to make assumptions about the Iran conflict, noting that one could even look at the last week to see the uncertainty surrounding it.
How concerned is the Bank about food prices?
Bailey said the Bank had been asked about food prices and that, so far, the information suggested food inflation was lower than expected. He said he had been struck by the large proportion of energy costs in food costs four years ago, when inflation soared after Russia’s full-scale invasion of Ukraine.
He added that the Bank was also watching reports about a possible El Niño weather system building, although he admitted he was not a climate expert.
Why did the Bank decide to keep rates on hold?
Deputy governor Clare Lombardelli said it was not a close call to hold rates. She cited the length of the conflict and said energy prices had found something of a ceiling, while the Bank was still watching for evidence of second-round effects on inflation.
Bank of England governor Andrew Bailey said the backdrop of relatively weak household demand reduced the ability of businesses to pass on price rises to customers. He also said the lack of spare capacity in the labour market meant people may struggle to get higher pay packets.
However, Bailey said the lack of evidence so far did not rule out second-round effects emerging later, and he described the Bank’s assessment as “tentative” at this point.
He also said there were “significant moves” in oil markets and highlighted the fall in supply of refined products. He said the size and duration of the outlook for energy prices was a key uncertainty for UK inflation.
Bailey said Ofgem’s price cap would rise to about £1,600 for an average household energy bill. He said the Bank had to watch carefully that the direct and indirect effects of inflation did not get embedded into businesses’ and households’ expectations, while adding that reassuringly there was little evidence of those second-round effects.
What do policymakers think about the risks?
Dave Ramsden, another deputy governor, said the balance of risks on inflation was tilted to the upside. Clare Lombardelli said the Bank had learned that the conflict could go on for longer, but also that the most extreme energy price scenarios had not come to pass.
Bailey said the Bank had to set policy now and try to look through the uncertainty. He raised the possibility of an “episodic” war in Iran and said that if the conflict in the Middle East persisted, it was likely the Bank would have to tighten policy. But he said it could be looser monetary policy if there was peace.
He said the situation in the Middle East was “highly uncertain”, but that policymakers had to make decisions now. He also said there was quite a lot of evidence that profit margins were taking more of the cost pressures, though there was still a long way to go on that.
How are markets reacting to the decision?
The probabilities of a “no change” decision at the next meeting in September were still inching up as investors digested the Bank of England’s statement. Investors appeared to be focusing on the Bank’s view that it did not see much evidence of “second-round effects” from the oil price increases caused by the US-Israeli war in Iran.
In other words, oil prices were up and directly affecting businesses and households, but there was not much evidence that businesses were then lifting their own prices to account for that.
What did economists say about the Bank’s guidance?
Rob Wood, chief UK economist at Pantheon Macroeconomics, said:
“The committee’s guidance looks slightly less hawkish to us. The MPC inserted a sentence in the Monetary Policy Summary saying that “There is little evidence so far to suggest such [second-round] effects, and there have continued to be clear signs of underlying disinflation in recent data”.
Granted, the rest of the minutes signal that limited evidence of second-round effects so far is far from surprising given the usual lags. The committee concluded that the arguments “warranted caution in placing too much weight on initial evidence in determining the possibility of stronger second-round effects.”
He said the wording suggested the committee was being somewhat less hawkish, although the minutes also stressed caution about relying too much on early evidence.
Why did Catherine Mann change her vote?
Catherine Mann changed her vote in favour of interest rate hikes because Donald Trump’s renewed attacks on Iran were a key reason, as well as the need to establish “policy credibility” by raising rates when inflation rises.
In the Monetary Policy Summary published by the Bank, she wrote:
“Most indicators of nominal conditions have continued to moderate, although near-term inflation estimates skirt the inflation attentiveness threshold at which research suggests stronger second-round effects, which would build on an inflation rate that has remained above target for five years.
That said, the key change in the environment for my decision is the collapse of the US-Iran memorandum of understanding, the widening of the Middle East conflict, and the associated volatility in energy prices. This “sporadic continuance” of the conflict that I hypothesised last month appears to be the state of play.
The shocks and volatility transmit through salience and production costs to affect expectations and price setting behaviours to impart an upward ratchet to CPI inflation.
A variety of research methods concludes that Bank Rate should be higher than 3.75% to return inflation to the 2% target sustainably. Other research emphasises that the costs of leaning against upside risks that fail to materialise would be smaller than the cost of leaning too little against upside risks. Notwithstanding moderately restrictive nominal financial conditions, reinforcing policy credibility when faced with inflationary shocks implies that a 25 basis point increase in Bank Rate is appropriate at this time
Her comments indicated that the widening conflict and energy-price volatility had changed her view, and that she believed a rate rise was warranted to support credibility and guard against inflationary risks.
What are businesses and trade groups saying?
Donald Trump’s renewed attacks on Iran have caused concerns that inflationary pressure may build again. But for now that has not come through clearly, leaving a majority of the Bank of England’s ratesetters content to wait before raising interest rates.
Alpesh Paleja, deputy chief economist at the Confederation of British Industries, the biggest UK business lobby group, said:
“One silver lining is that the Bank is starting from a relatively more favourable position. Prior to the latest escalation, energy prices had fallen back significantly. Inflation and wage data have also come in lower than previously expected. Moreover, a looser labour market should also help limit the pass-through into broader domestic price pressures.
These competing influences on inflation mean that interest rates will likely remain on hold for now. Globally, much depends on the duration and intensity of the renewed energy price shock. Closer to home, the Bank may also wait for greater clarity on the fiscal outlook as we head towards the new chancellor’s first budget in the Autumn.
His comments suggested the Bank had a better starting point than during earlier inflation shocks, but that the next steps would depend on how long and how severe the energy shock became, as well as on the fiscal outlook ahead of the new chancellor’s first budget in the Autumn.
Suren Thiru, chief economist at the Institute for Chartered Accountants (ICAEW), said:
“Keeping interest rates on hold is a predictably pragmatic response to the conflicting realities of softer-than-expected inflation on the one hand and renewed US-Iran hostilities threatening a fresh wave of price rises on the other.
The tighter vote split in favour of this outcome confirms a further hawkish shift within the committee with inflation worries outweighing concerns over the economy, keeping a September rate rise on the table.
He said the narrower vote split showed a further hawkish shift within the committee, with inflation concerns outweighing worries about the economy and leaving a September rate rise on the table.
What should readers take away from the decision?
The Bank of England’s decision reflected a cautious wait-and-see approach as policymakers monitored the inflationary impact of the conflict involving Iran and the wider Middle East. Officials said there was little evidence yet of second-round effects, but they also warned that energy prices and expectations could still change the picture.
For now, most ratesetters were content to hold, while a tighter vote split and Catherine Mann’s support for a rise showed that some policymakers are becoming more concerned about the risk of inflation staying higher for longer.
Key Facts
- The Bank of England held interest rates steady.
- Andrew Bailey said higher energy prices would push up inflation in the coming months.
- Clare Lombardelli said it was not a close call to hold rates.
- Ofgem’s price cap will rise to about £1,600 for an average household energy bill.
- Catherine Mann voted for a 25 basis point increase in Bank Rate.
